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A Simple and Proven Way to Beat the Market

A mistake that novice investors sometimes make is to attempt to get rich quick by risking a majority of their portfolio on a speculative stock in an effort to find the next Apple or Priceline.com. More often than not, this strategy ends up being a costly mistake.

There is a better method of investing that is simple and has been proven effective: investing in a diverse group of premier dividend-paying companies, holding for the long term, and reinvesting the dividends. This method can create an amazing compounding effect over the long term when you invest in companies with the following traits:

A diverse mix of products/services

A business model that has stood the test of time

Well-known brands

Global operations

Excellent dividend history

A compelling health-care exampleOne company with all of these traits is Johnson & Johnson (NYSE:JNJ). Health care is one of the safest and most rewarding sectors to invest in, andJohnson & Johnson is one of the most compelling opportunities within this sector.

Johnson & Johnson has an uncanny ability to maintain a large number of market-leading products over a broad spectrum of health care categories. One of the reasons for this success is its ability to focus on the future. An example is its recent purchase of Synthes, J&J's largest acquisition ever.

Synthes added a wide variety of impressive trauma, orthopedic, and neurological products. These will complement J&J's medical-device and diagnostics business segment, which is particularly well-positioned to benefit from the projected growth of the elderly population.

Johnson & Johnson's pharmaceutical business segment has performed well recently due to excellent results from Remicade (inflammatory diseases), Velcade (multiple myeloma), and Prezista (HIV). This success should continue due to a large number of recent product launches, such as Sirturo (tuberculosis) and an impressive group of late-stage product candidates, including Invokana (type 2 diabetes).

Compound your returns with Johnson & JohnsonThe following chart illustrates the compounding effect that a Johnson & Johnson investor would have achieved by making a $1,000 purchase (19.87 shares at $50.33 per share) 10 years ago and reinvesting the dividends:

Johnson & Johnson

Annual Dividends per Share

Dividends Received

Cumulative Dividends

Total Shares

Share Price

Portfolio Value

Year 1

$1.05

$21.12

$21

20.25

$58.38

$1,182

Year 2

$1.23

$25.21

$46

20.63

$62.62

$1,292

Year 3

$1.41

$29.50

$76

21.10

$67.40

$1,422

Year 4

$1.58

$33.84

$110

21.61

$65.17

$1,408

Year 5

$1.75

$38.38

$148

22.03

$61.34

$1,351

Year 6

$1.90

$42.66

$191

22.74

$59.05

$1,343

Year 7

$2.06

$47.80

$239

23.49

$63.74

$1,497

Year 8

$2.22

$53.35

$292

24.34

$64.39

$1,567

Year 9

$2.36

$58.78

$351

25.25

$70.82

$1,788

Year 10

$2.54

$65.54

$416

26.10

$92.61

$2,417

Note: JNJ's October closing price each year was used for the share prices, and the closing share price on the ex-dividend date was used to determine the number of shares purchased with each dividend.

The cumulative dividends added up nicely to nearly 42% of the original investment. The total return of 142% is nice, but the exciting part of this story is the future. If this sort of performance -- i.e., annual dividend growth of 8% and annual share-price appreciation of 5.95% -- were to continue for another decade (20 years total), the $1,000 investment would be worth $5,872, including $1,655 of cumulative dividends. Taking this one step further, after a total of 25 years the investment would be worth $9,375, including $3,027 of cumulative dividends.

Over the long term, this investment turns into a cash-generating machine. Due to its 2.9% dividend yield, combined with an impressive streak of 51 consecutive years of dividend increases, I believe now is an ideal time to open a long-term position in Johnson & Johnson.

A focused health-care companyA competitor of Johnson & Johnson that is focused strictly on pharmaceuticals is Pfizer(NYSE:PFE). Pfizer lacks Johnson & Johnson's overall health-care diversity but has one of the most diverse and impressive groups of pharmaceutical brands, including Celebrex, Lyrica, Viagra, and Sutent.

In 2011, Pfizer lost patent protection with Lipitor, the best selling drug of all-time. In anticipation of Lipitor's patent expiration, Pfizer acquired Wyeth in 2009 to offset the effects of the patent expiration. As a result, the company cut its dividend by 50% to recover a portion of the acquisition costs. However, Pfizer has increased its dividend every year since this dividend cut and currently yields 3.1%.

Now that Pfizer has made it through the Lipitor patent expiration, it is in a very good position going forward. It has recently launched a large number of new products with high potential such as Xeljanz (psoriasis) and Bosulif (cancer). Its pipeline is impressive as well with a large number of phase III candidates with high potential.

As a result of its future product potential combined with its nice dividend, I believe that Pfizer deserves consideration as part of the dividend reinvestment strategy described above.

An outstanding dividend growth opportunity within the health care sectorThe world's population is projected to grow significantly over the next couple of decades, and as a result, the need for quality health insurance and programs will increase as well.

UnitedHealth's recent dividend growth has been phenomenal, resulting in a 31% increase per year over the last three years. With a current dividend yield of 1.4% and a payout ratio of only 18.5%, I believe UnitedHealth would be a great candidate for the dividend reinvestment strategy described above.

The Foolish bottom lineBy allocating a significant portion of your portfolio to solid dividend-paying companies, you will be able to sit back and enjoy the ride while watching your money compound.